January 4, 2023 – 

Accessing the Public Equity Markets – Benefits and Challenges

The public equity markets have long played an important role in providing public issuers with financing necessary to grow and innovate, while giving investors access to attractive returns.1 But public issuers face unique challenges as well. In particular, investors (and analysts who report on public issuers) may overemphasize near-term financial results at the expense of longer-term objectives. 

In 2013, Dell was taken private in a $24.9 billion leveraged buyout 25 years after its initial public offering on Nasdaq. A year later, the company’s eponymous CEO Michael Dell, penned an op-ed for the Wall Street Journal where he noted:

“The single most important thing a company can do is invest and innovate to help customers succeed. Theoretically this should also be good for shareholders. You do what’s best for customers, you grow and generate returns, and a stable base of long-term shareholders benefits from success… Yet we find ourselves in a world increasingly afflicted with myopia… as a public company [Dell’s] shareholders increasingly demanded short-term results to drive returns; innovation and investment too often suffered as a result. Shareholder and customer interests decoupled.”2

At the time, this observation resonated with many. As a result, the number of public issuers declined gradually for more than a decade. This development reversed in 2020: on the back of an epic bull market, the COVID-19 pandemic saw a wave of companies accessing the public equity markets for the first time, some by way of a traditional IPO, many others by merging with a publicly traded special purpose acquisition company (SPAC) (we refer in this article to the publicly traded combined business resulting from such a merger as a “deSPAC Company”).3

Among this new cohort of deSPAC Companies were many innovative startups with the potential to disrupt their industry. Those startups had long preferred remaining private and prioritizing investment and innovation over profitability. As an asset class, these privately held startups were available only to a select group of accredited investors with access to private placements, and not to retail investors. Then, the historically beneficial market conditions in 2020 and 2021 provided abundant public equity capital, and many startups heard Wall Street’s call.

However, deSPAC Companies had to adjust to public market scrutiny, and learned that public markets are volatile and cyclical. The dilemma described by Michael Dell became the new reality of this newly minted class of public issuers, aggravated by the 2022 environment of higher inflation and tighter monetary policy, increasing pessimism around the global economy, Russia’s invasion of Ukraine, supply chain issues and the continued impact of COVID-19. These factors resulted in U.S. and global stock market indices declining steeply, with the technology sector suffering the greatest losses.4 Many deSPAC Companies saw their stock price fall in 2022 and, with some exceptions, have significantly underperformed the market as a whole.5

The reasons for such underperformance are case-specific. That said, of the 10 largest IPOs from 2021, six issuers went public through the traditional IPO process while four went public through deSPAC; only one of the six traditional IPO issuers had de minimis revenue, while two of the four deSPAC issuers did.6  Also, in many deSPAC transactions, the SPAC includes projections in its deSPAC proxy/prospectus. A failure of deSPAC Companies to meet the publicly disclosed projections may intensify existing downward pressure on their stock price.7

These developments may trigger a wave of going private transactions involving deSPAC Companies. DeSPAC Companies may be facing similar pressure from investors and analysts to the pressure faced by Dell. Founders and/or senior management of deSPAC Companies may be inclined to take them private again, as did Michael Dell. Moreover, lower valuations may attract takeover advances from more mature strategics or private equity. Also, with a low stock price and higher borrowing costs,8 management of deSPAC Companies may find it challenging to unlock financing, especially important for companies still in their growth stage. That, in turn, may eventually make a sale of the deSPAC Company inevitable.

Romeo – Case Study of a “Going Private” by a deSPAC Company

It took 25 years following Dell’s IPO for it to go private. It took one deSPAC Company, Romeo, less than two.

In October 2020, Romeo Systems Inc., an electric vehicle (“EV”) battery manufacturer, announced it was going public through a merger with SPAC RMG Acquisition Corp. (“RMG”) in a deal that, at signing, valued the combined entity (“Romeo”) at approximately $1.3 billion. In its deSPAC proxy/prospectus, RMG’s projected 2021 and 2022 revenue was $139.8 million and $411.9 million, respectively, while its actual revenue was only $16.8 million in 2021 and $17.3 million for the first six months of 2022. At closing, Romeo’s stock traded in the mid-$30s (resulting in a total market cap of approximately $5.2 billion), before steadily declining; by May 2022, Romeo’s stock was trading under $1 per share.

The dramatic decline in Romeo’s share price exacerbated a liquidity crisis, and in August 2022, with a potential bankruptcy looming, Romeo and Nikola Corporation (Romeo’s largest customer, a Nasdaq-listed EV infrastructure company and itself a DeSPAC Company) announced a definitive agreement pursuant to which Nikola would make an offer to Romeo’s shareholders to exchange their Romeo stock for Nikola stock, to be followed by a merger after which Romeo would be a wholly-owned subsidiary of Nikola. The transaction was valued at approximately $67 million in the aggregate.9The transaction was completed in October 2022 – less than two years after Romeo went public.

Coming Wave of Going Private Transactions Involving deSPAC Companies?

Nikola’s acquisition of Romeo may presage a coming wave of deSPAC Companies going private. Faced with a sustained decline of the stock price, boards of directors of public issuers have to evaluate strategic alternatives. Boards of directors of DeSPAC Companies considering a going private transaction will need to consider a range of commercial and legal questions in determining whether a going private transaction is the right choice. Among others, a deSPAC Company will need to consider the following legal factors:

  • Structure of Transaction. As a public company, a deSPAC Company would typically go private by way of a negotiated merger (one step) or a tender or exchange offer followed by a “squeeze-out” merger (two step).

    A one-step merger requires negotiation with, and approval by, the board of directors of the deSPAC Company, followed by approval of the requisite percentage of shares (in Delaware, a majority of the outstanding shares of capital stock). But Delaware corporate law also permits squeeze-out mergers following a tender offer where the acquirer holds a majority of the outstanding shares of capital stock.10

    In hostile going private transactions – where the board of the deSPAC Company has not recommended the acquisition and is not cooperating with the potential acquiror – the transaction will need to be structured as a tender or exchange offer to allow the potential acquiror to proceed without the cooperation of the board.

    In negotiated going private transactions of Delaware corporations, either a one-step merger or a two-step transaction will likely be viable (although a two-step transaction may result in the acquiror obtaining a control position faster, assuming it is conditioned upon acceptance by holders of more than 50% of the outstanding shares). 
  • Fiduciary Duties. DeSPAC Companies are typically structured as Delaware corporations (“onshore corporations”), or Cayman, Dutch or Luxembourg corporations (“offshore corporations”). In Delaware, directors owe fiduciary obligations to all stockholders; in addition, controlling stockholders owe fiduciary duties to minority stockholders.11 
    Directors or controlling stockholders of offshore corporations may similarly have fiduciary obligations. 

    If the going private transaction results in a Delaware deSPAC Company being acquired by a third-party acquirer (as with Romeo), the directors’ performance of their fiduciary duties will, assuming they are not conflicted, be analyzed under the “business judgment” rule. This rule, as a general principle, puts the burden of proof on the plaintiff and protects directors from judicial hindsight (and therefore liability). In a takeover context, Delaware courts would apply heightened scrutiny under the “Revlon” doctrine which requires the directors to seek the highest value for the target’s shareholders that is reasonably attainable.

    On the other hand, a going private transaction with an acquirer that is already controlling the target (or, as was the case with Dell, may be considered a controlling stockholder of the target)12  may result in the application of the “entire fairness” standard. The entire fairness standard will require the directors and/or controlling stockholder to show the transaction was entirely fair to the minority stockholders, both in terms of process by which the transaction was entered into, and in terms of the price obtained for the sale.13   This is a high bar.

    In any case, directors of a deSPAC Company may be reticent to approve a going private transaction at a significant discount to the deSPAC valuation, even if the share price has fallen precipitously since the deSPAC, as was the case with Romeo. In particular, if they were on the board at the time of the deSPAC closing, directors may be concerned about lawsuits from PIPE investors (who will typically have invested at $10 per share at the time of the deSPAC, and unlike the SPAC investors, without redemption rights). Engaging a financial advisor to provide a fairness opinion (as Romeo did in its going private transaction) may be advisable even where the acquirer is a third-party to protect the board and management against claims for breach of the duty of care. Even where minority protections are applied, directors approving the transaction will want to ensure that they are covered by a D&O insurance policy and/or the indemnification provisions of the company’s governing documents in light of potential claims from minority stockholders (and the always litigious plaintiff’s bar). 
  • Disparate Shareholder Base. Alternatively, absence of one or a group of controlling shareholders may create practical difficulties in approving a going private transaction. It is notoriously difficult to get retail investors to vote; for example, in August 2022, DWAC (the SPAC involved in the proposed Truth Social deSPAC) was unable to obtain shareholder approval for extension of DWAC’s SPAC life despite the share price trading well above the per share liquidation value. As a result, DWAC’s sponsor had to overfund the trust account to trigger an automatic extension. Moreover, retail investors will most likely have purchased their shares in the deSPAC Company at market prices, whereas SPAC IPO investors and PIPE investors will typically have paid $10 per unit or per share, respectively, and SPAC sponsors will have received their shares for nominal consideration; hence, the valuation of the deSPAC Company in a going private transaction may be attractive to some groups of shareholders and not to others. Accordingly, the stockholder base and any resulting difficulties in obtaining transaction approval should be carefully reviewed when considering a going private transaction.
  • Derivative Securities. The typical SPAC goes public through the issue and sale of units for $10 per unit. Those units generally comprise of one Class A common share and a fraction of a warrant to purchase one Class A common share at $11.50. Even where the overwhelming bulk of a SPAC’s Class A common shares are redeemed in connection with the deSPAC closing in return for a pro rata share of the trust account balance, the warrants that formed part of the IPO units will remain outstanding until redeemed or exercised in accordance with their terms. Consideration should be given to the specific terms of the warrants and any other outstanding classes of securities. In stock-for-stock deals, warrants of the deSPAC Company will often be exchanged for warrants to purchase shares of the acquiror, with the number of shares issuable upon exercise of the warrants and the exercise price being adjusted based on the exchange ratio. At times, the terms of the warrants may stipulate that the exercise price is subject to reduction if the anti-dilution provisions are triggered.
  • Heightened Disclosure Obligations May Apply. If an affiliate of the deSPAC Company is engaged in the going private transaction, such as where a controlling shareholder is seeking to take a deSPAC Company private, Rule 13e-3 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), would require heightened disclosure for the benefit of minority shareholders.14 Such disclosure would be included in the front of the tender offer or proxy statement disclosure documents, in a section titled “Special Factors.” In the current era of heightened SEC scrutiny around all things SPAC-related, conflicts disclosure and methods by which the conflicts were reviewed and cleansed will need to be considered carefully.
  • Lock-Up Period. The deSPAC Company capital stock held by many of the constituencies in a deSPAC will often be subject to a lock-up period (typically one year, although oftentimes there will be an early release if the deSPAC Company’s stock trades above certain thresholds for a certain period of time). The terms of any such lock-ups should be considered and waivers may be needed to permit the holders of shares subject to lock-ups to vote in favor of a merger or to tender their shares in a tender offer.

As summarized above, there are certain legal issues that will be commonly faced in connection with potential going private transactions. However, particularly in respect of deSPAC companies each potential transaction will be unique based on the potential target’s capital structure, management, the interests of various parties, and contractual terms by which the public issuer and its key shareholders are subject. In addition, hostile takeovers will invariably raise a host of issues not covered in this analysis.

To aid a potential acquiror or target in structuring a potential going private transaction, legal and financial advisors should be brought into the loop at the early stages of a potential transaction to help prepare a realistic and efficient path to successful closing.

  1.  Based on calculations of the NYU Stern School of Business, the average S&P 500 annual return since it adopted 500 stocks into the index in 1957, through December 31, 2021, is approximately 11.9% on a gross basis (assuming reinvestment of dividends).
  2. Wall Street Journal, November 24, 2014. ↩︎
  3. According to Statista, 53% and 58% of companies going public did so by way of deSPAC in 2020 and 2021, respectively, compared to only 10% and 16% of companies going public in 2016 and 2017, respectively. SoFi reported that the number of IPOs more than doubled from 2019 to 2020, and then more than doubled again from 2020 to 2021 (going from 232 in 2019 to 480 in 2020 and then 1,035 in 2021). ↩︎
  4.  On October 14, 2022, the tech-heavy NASDAQ was down more than 35% from its all-time closing high of November 19, 2021. Also on October 14, 2022, the S&P 500 index closed down approximately 22% from its all-time closing high of November 19, 2021 ↩︎
  5.  Over the same time period referenced in footnote 4, according to FactSet Research, the De-SPAC Index declined by nearly 75%. ↩︎
  6.  One of the six traditional IPO issuers had no revenue in its prior fiscal year, while the other five had revenue ranging from $21.6 billion to $332 million; two of the four deSPAC issuers had less than $5 million of revenue in their prior fiscal year, while the other two had revenue ranging from $565 million to $469 million
  7.  Contrast Romeo (described below) with Bowlero Corp., another deSPAC Company. In its proxy/prospectus, the acquiring SPAC, Isos Acquisition Corp., included revenue and Adjusted EBITDA projections for FY2022 of $772 million and $244.8 million, respectively; Bowlero’s actual revenue and Adjusted EBITDA for FY2022 was $911.7 million and $316.4 million, respectively. Bowlero’s closing share price on December 2, 2022 was $13.66, or approximately 40% above the closing price at the time of the de-SPAC in December 2022.  ↩︎
  8.  According to BMO, new high-yield issuances in October 2022 indicated a 12.8% yield, compared to a 6.6% yield twelve months earlier. ↩︎
  9. Based on approximately 22 million shares of Nikola stock being issued, based on a closing share price on October 14, 2022 (the date of closing), of $3.06. ↩︎
  10. See Section 251 of the DGCL. Unlike Delaware, many other states require the acquirer hold 90% of the target’s shares to effect a squeeze-out merger. ↩︎
  11.  See, example, Kahn v. Lynch Communication Sys. Inc., 638 A.2d 1110 (Del. 1994). Many Post-SPAC Companies are “controlled companies” or otherwise have significant stockholders which may trigger fiduciary obligations.  ↩︎
  12.  At the time of the Dell go-private transaction, Michael Dell served both as Board Chair and Chief Executive Officer, and owned approximately 13% of the company’s voting power. Given that, and the fact that Michael Dell was going to control the post-transaction company, the transaction was structured to comply with the minority stockholder protections described in footnote 13 below. ↩︎
  13.  Broadly speaking, a transaction that must meet the “entire fairness” standard shifts the burden of proof to the defendant directors, and requires a showing that the transaction was fair as to both price and process. Under Delaware law, an acquisition by a controlling stockholder that would otherwise be reviewed under the entire fairness doctrine will instead be reviewed under the business judgment rule if certain minority stockholder protections are applied, including the terms of the transaction being negotiated, and the transaction being approved, by a special committee comprised solely of independent directors, and the transaction and its terms being approved by a majority of the minority stockholders in a fully informed, uncoerced vote. 
  14.  Of particular note is the fact that Rule 13e-3 requires disclosure of alternatives considered and information on the fairness of the transaction (Items 7 and 8 of Schedule 13E, respectively).